Diagnosing the Spanish Flu: Monetary Union Dynamics Through the Lens of Spain, the United Kingdom, and Florida

Abstract

I compared Spain, the United Kingdom, and Florida beginning in the precrisis boom period and extending to the present in order to elucidate the effects of monetary union on crisis recovery. This topic is compelling at present, since the idea of the Eurozone has lost favor among many European economists as well as the general public. The crisis was sharpest and deepest in Florida but Florida’s pace of recovery has been the quickest. The U.K. experienced a mild and relatively short crisis, in part because there had been no excesses in construction and in part because of its competent financial sector resolution policies. Spain appeared to be relatively insulated from the crisis early on, but it has suffered the longest crisis. While recently many have hailed recent Spanish stabilization as the beginning of a broad-based and long-term recovery, this thesis questions that notion. In judging the boom and ensuing crisis and recovery, I considered both the underlying vulnerabilities and the policy response. I found that construction, which has been recognized as a potent source of business cycles, played a key role in generating vulnerabilities through its effects on investment, lending, and GDP. While the U.K. had greater flexibility to create monetary policy shock absorbers (and did do so), Florida and Spain were part of a monetary union and did not have independent monetary policies. However, Florida’s needs, as measured by inflation, matched the U.S. monetary union much closer than Spain’s did the Eurozone. Spain thus suffered procyclical monetary policy in the boom period, and presently, as Spanish deleveraging occurs, nominal and real interest rates are rising. Florida’s crisis was also offset by sizeable fiscal support from the U.S. federal government, but Spain received no such support and instead felt compelled to embark on a fiscal austerity program. Spain is now threatened by a debt-deflation cycle from the combination of deleveraging, rising real interest rates and disinflation, and austerity. Spanish adjustment is occurring through a sizeable migration—one that is much greater than in Florida. Spain’s emigration may have mixed result, however, due to its composition primarily of the young and educated.